To clearly understand the coffee futures market, a
distinction must be drawn between physical (cash) coffee and coffee futures.
In the coffee cash
market, participants buy and sell
physical, green coffee of different qualities that will be delivered either
immediately or promptly. The cash transaction therefore involves the transfer of
the ownership of a specific lot of a particular quality of physical coffee. The
cash price for the physical coffee is the current local price for the specific
product to be transferred. (Note that sales of physical, green coffee for later
(forward) delivery, called forward contracts, are not to be confused with
futures contracts.)
In the coffee
futures market, participants buy and sell a price for a standard quality of coffee. The
futures transaction centres around trading a futures contract based on physical coffee (or its cash equivalent)
at a price determined in an open auction - the futures market. The futures price
is the price one expects to pay, or receive, for coffee at some future date.
- Cash
price = price now for coffee (by trading the physical product for
immediate or prompt delivery)
- Futures
price = expected price for coffee (by trading the different positions
of the futures contract)
The futures
contract is a standardized legal commitment to deliver or receive a
specific quantity and grade of a commodity or its cash equivalent on a specified
date and at a specified delivery point. Its standardization allows the market
participants to focus on the price and the choice of contract month.
Traders in the futures markets are primarily
interested in risk management (hedging) or speculation, rather than the physical
exchange of actual coffee. Although delivery of physical coffee can take place
under the terms of the futures contract, few contracts actually lead to
delivery. Instead purchases are usually matched by offsetting sales and vice
versa, and no physical delivery takes place.
In addition to its pricing functions, the coffee
futures market also serves to establish standards of quality and grade that can
be applied throughout the industry.